Resuming stalled construction and real estate projects and increasing investment high on Peru's list

After contracting the previous year, the construction sector is looking to grow again in 2017. Still feeling the impact of the recent downturn, the sector is only expected to register growth in the fourth quarter, following the negative effects of the coastal El Niño floods in early 2017. While causing significant damage, the floods made it necessary for the newly elected government of President Pedro Pablo Kuczynski to draft an ambitious $3bn reconstruction plan from which the construction sector will benefit in the medium to long term. The government foresees over $9bn worth of investments in the sector in the coming five years.

A Rough Start

The fall in private investment has led to a significant decrease in the number of infrastructure projects since 2015. As a result, the sector contracted by 5.8% in 2015 and 3.1% in 2016. Apart from the wider economic situation, challenges facing the sector include a complex permit system, which the Kuczynski government is seeking to simplify.

The sector is now focused on projects to rebuild parts of the country after the damaging coastal effects of El Niño, and is also determining how to follow the increased activity of the mining sector. However, delays to a number of major projects – some related to the corruption scandal involving Brazilian company Odebrecht – are likely to affect the sector. Contracts for major projects, including the Southern Peru Gas Pipeline, the Chavimochic III irrigation project, Line 2 of the Lima Metro and the construction of a new international airport in Cusco have either been put on hold or cancelled altogether. The government has expressed desire to find new investors to complete these projects.

All these elements contribute to a challenging scenario, with some analysts suggesting that a full recovery may not occur until 2018-19, once the government’s plans to rebuild flood-affected areas begin to have a positive impact. Despite these hurdles, 2017 is likely to see increased activity in the sector. “This year we will grow slightly and next year we will match the estimated GDP rate of 4%, but the big rebound will only be seen in 2019,” Guido Valdivia, executive director of the Peruvian Chamber of Construction, told local press. Other analysts predict a recovery in construction activity by the end of 2017, with contractions in the sector expected to remain for the first three-quarters of the year.

Public & Private Investment

Increased government resources dedicated to the development of infrastructure, coupled with the need for construction to accompany a rebounding mining industry, is expected to help private investment rise in 2017 after three consecutive years in the red. In April 2017 the Ministry of Economy and Finance (MEF) projected a 0.5% rise in private investment in the sector by the end of the year. According to the public body, the upward trend will be maintained over the coming years, increasing by 5% in 2018, 5.7% in 2019 and 6.3% in 2020. This is in contrast to the past three years, where private investment fell by 1.6% in 2014, 4.4% in 2015 and, the largest rate of contraction, 6.1% in 2016.

While a wide variety of infrastructure projects are urgently needed, housing will largely be responsible for the return of private investment to Peru. According to the Economic Construction Report (Informe Económico de la Construcción, IEC), investments in new construction projects will rise by 2.82% year-on-year (y-o-y) in 2017, with growth focusing on new real estate projects, which are forecast to rise by 4%.

Public infrastructure is expected to lead investment growth, according to the report, and expectations on the development of public-private-partnerships (PPPs) are not overly optimistic, leading many to argue that housing holds a more positive performance outlook. There may also be other issues detrimental to infrastructure investment in construction, with the IEC highlighting the effects of latent corruption as a concern. As surveyed in the report, two-thirds of infrastructure development companies say these events have “significant influence” on private investment decisions.

The IEC notes that construction companies expect the sector to grow by 2% in 2017, a slightly higher forecast than the 1.8% projected by the Central Reserve Bank of Peru in its March 2017 inflation report. Reflecting on recent challenges, the MEF estimated that the so-called “Odebrecht Effect” – from a scandal related to the Brazilian company – resulted in a 13% drop in private infrastructure investment in the country. However, despite the country’s current challenges and urgent needs, the ministry projected in its macroeconomic assessment that the construction sector will grow by 3.8% in 2017, increasing to 4.5% by 2018.

In order to facilitate growth, some public measures have been put in place. The MEF highlights the importance of quickly re-tendering projects paralysed by their links with companies affected by corruption scandals. It also believes an increase in PPPs would be beneficial, and foresees projects with a value of $7bn between 2017 and 2018. The development of the Works for Taxes framework, which allows companies to pay tax through the execution of public works projects, should also help boost the sector. Daniel Córdova, executive president of Grupo Invertir, told OBG, “The Works for Taxes scheme, which is unique in the world, has proven effective at decreasing the infrastructure gap, as it requires less public sector involvement, thus minimising corruption and bureaucracy.” THE EL NIÑO EFFECT: At the end of January 2017 the weather cycle known as El Niño hit the coasts of Peru and Ecuador. The climate phenomenon, which makes the water temperature rise along the sea borders of the two Latin American countries, can have devastating environmental effects.

The economic effects of the latest El Niño are yet to be defined. However, it seems the phenomenon was considerably more destructive than in 1983 and 1998, when similar weather patterns last hit Peru’s coast. Hundreds of thousands of people have been affected as a result, with hundreds of bridges, houses, schools, hospitals and other infrastructure destroyed.

In response, the government has increased efforts and directed more budgetary resources towards rebuilding affected areas. While it has been suggested investments of up to $15bn will be injected into Peru, the challenge is to prioritise the use of resources and spend them efficiently. Investments in cement, steel and other construction materials will necessarily rise.

As part of the rebuilding efforts, Congress in April 2017 passed the Law for Reconstruction with Changes, which created the Authority for the Reconstruction with Changes, the body in charge of the reconstruction process. The law regulates the implementation of a three-year comprehensive plan and also establishes that the agency’s executive director must hold a cabinet-level position. Among other developments, the law allows the use of the country’s natural disaster fund – estimated at PEN5bn ($1.5bn) – for the development of infrastructure projects through the Works for Taxes scheme. Furthermore, the MEF approved the allocation of an additional $6.4bn to be used in reconstruction efforts. The new law aims to simplify licensing processes, in the hope of reducing project approval time from an average of 10 months to four months.

Roque Benavides, president of the National Confederation of Private Businesses, stressed to media that the concessions would play a very important role in the reconstruction of affected parts of the country, underlining the role of the private sector in this situation. “Investment in highways will have to run on behalf of the concessionaires and their insurance companies,” he said, while highlighting the importance of spending the funds in a transparent manner. “I hope we build better infrastructure and the reconstruction is done without corruption,” he said.

Working With Mining

While the El Niño floods altered projections for the sector, mining remained fairly strong in the early stages of 2017. The fact that construction is closely linked to the mining sector is certainly beneficial, as the latter’s rise in activity in early 2017 has led to an increased demand in large investments in both infrastructure and general construction. This, combined with investments coming from the public sector, helped construction register 5.37% y-o-y growth in February 2017, according to the National Statistics Institute. A small contraction in the sector was reported for the following month.

Internally, there is also a great deal of confidence about the sector, with a report from the National Society of Mining, Petroleum and Energy predicting that half a dozen mining projects will become operational in the short term. The Ministry of Energy and Mines’ January 2017 report indicates that proposals with approved environmental title and authorisation for construction include projects at Quellaveco (in the country’s southern Moquegua region), Ollachea (Puno), Conga (Cajamarca), Crespo (Cusco), Shahuindo Shouxin (Ica) and Tambomayo (Arequipa). Investments will be allocated in the construction of the San Gabriel mine, while the company Southern Copper will continue with its expansion of the Toquepala open-pit mine.

After Odebrecht

The corruption scandals linked to Brazilian company Odebrecht, which came about as a result of the “Lava Jato” police investigation, has undoubtedly affected Peru’s construction sector and the economy as a whole. In fact, delays to projects such as Line 2 of the Lima Metro or the Southern Peru Gas Pipeline could reduce the country’s GDP by 0.5%, according to credit agency Moody’s.

As a result of the scandals, the Kuczynski government has focused on safeguarding Peru’s image to local and international investors, with officials prioritising the resumption of significant projects that were stopped. This includes the aforementioned gas pipeline, the Olmos irrigation and hydroelectric power project, and the development of sections 2 and 3 of the Initiative for the Integration of Regional Infrastructure in South America (IIRSA) South Highway, which plans to connect Cusco to the Brazilian border via the Inambari bridge. The scandals have also impacted the third stage of the $597m Chavimochic irrigation project. Taken together, these major projects account for almost 5% of the country’s GDP, which has prompted the government to prioritise unlocking their development.

The investment committed to these projects exceeds $9.3bn, with delays in execution implying a loss of dynamism that has broader affects across the whole economy. These issues have been compounded by the late execution of delayed PPPs which, according to local media, have an accumulated committed investment of $10.13bn, and include construction efforts associated with the Lima Metro, Jorge Chavez International Airport and the container terminal at Callao port.

Throughout 2017 and 2018 Peru’s government has also set out to execute a number of prioritised PPPs. According to official state figures, 61% of the prioritised investment ($48bn out of a total $79bn) is awaiting execution. Problems have been attributed to a lack of adequate identification processes and delays in sanitation approvals or appraisal of necessary land. Various executives highlighted the excessive regulation related to PPPs as an issue contributing to delays in execution.

Pending Projects Resume

Mining infrastructure, works on airports, the Lima Metro, along with upgrades to a number of industrial plants and oil and gas processing facilities, are expected to lead investments in the sector. Among the major concessions planned for 2017 is Line 2 of the Lima Metro, which needs to overcome a land disposal challenge before raising its investment and being finalised. A March 2017 report by the World Bank projects demand for Line 2 to reach 660,000 passengers per day when all phases become fully operational, which is expected by 2021.

In terms of airport infrastructure, 2017 is likely to see a $520m investment in the Chinchero International Airport. Preliminary work began in January 2017, however, the project has been delayed as lawmakers assess contractual changes. There is also the expansion of the Jorge Chávez International Airport which, after overcoming obstacles and interferences that have delayed works since 2005, is starting in the first half of 2017.

With regards to oil and gas, key projects include the Southern Peru Gas Pipeline, which is awaiting additional resources to resume work, and the modernisation of the Talara refinery – a project that also needs increased funding. According to industry analysts, funding for the Talara project could be raised through either a syndicated loan of $1.5bn or a bond issue of $1bn.

Energy infrastructure also extends to the hydrocarbons segment. Resources explorer GeoPark is expected to develop Block 64 in northern Peru, Gases del Pacífico and Fenosa will begin gas distribution in the north and south of the country, respectively, while the Repsol-run La Pampilla refinery will continue with its modernisation process. In the energy sector, REP Energy will also install more transmission lines and substations.

Industrial projects include the construction of concrete producer Unicon’s new plant, while Cementos Inka will also work on a ready-made concrete plant. In retail, supermarket chain Wong will open a mall in Santa María, Intercorp will expand the Real Plaza mall in Cusco, and Parque Arauco expects to open its Life Style shopping mall in La Molina in 2018.

Furthermore, the transport sector will also seek new construction projects. DINET and Transmeridian will open warehouses and distribution centres, while ICT players such as Telefónica, Claro, Entel and Bitel will expand their infrastructure networks and 4G coverage, suggesting that investments in infrastructure could lead to the sector’s revitalisation.

Outlook

The construction sector has encountered significant challenges that have coincided with the change of government in 2016. Corruption cases have halted a number of key projects, and PPPs have proved ineffective at times. While officials have prioritised transparency and regulatory issues, the outcome of the El Niño phenomenon has made things more difficult.

Still, expectations for the sector in 2017 remain positive, albeit conservative. The resumption of tenders takes time, while the positive impact of faster development of PPPs is not likely to be noticed until late 2017 or early 2018. Investment efforts to rebuild much of the country’s infrastructure will have a significant effect on local economies in the near future, and private investment should grow again in the next five years.